Like sticky little Venus flytraps, the nation’s bankers and mutual fund salesguys line life’s ditch waiting to eat you. Especially now. It’s RRSP season, and you are prey.
Today’s topic was scheduled to be a look at what REITs will do in 2012, after showering investors with a 22% capital gain last year, plus a 5% distribution, at a time when the TSX choked. What happens to real estate trusts when the housing market tanks? What effect will there be when the sky darkens with plunging condo investors? How much risk is there? And as the Amazons keep wondering in amazement, how long can it remain aloft?
However, many blog dogs have asked that I address the hoary issue of registered retirement savings plans. So let’s do it. Since 1957 when they were invented, these have been pushed hard as the no-brainer thing to do if you wanted to retire without grocery shopping at Pet Smart. But times have changed, and now we have the TFSA. It’s dawning on more people that ‘registering’ your retirement nestegg with the government might be the last thing sane folks do.
Of course, we all know the purported benefits of an RRSP. You get money back on your taxes since the contribution is deductible from taxable income. Your investments can swell free of tax. And when you retire you can withdraw money at a lower rate than when you contributed and received a refund.
In reality, though, sticking money into a plan just refunds taxes you’ve already paid – there’s no additional cash. Plus you are merely making those funds taxable once again. How smart is that? Tax-free growth has been an illusion for most investors in mutual funds or GICs over the past few years (the most popular choices), so kiss that one off. And, sadly, way too many retirees are finding their RRSPs are costing them more taxes, not less.
So, here are eight reasons RRSPs might suck (followed by some strategies).
First, let me emphasize a point already made: people make RRSP contributions with money they earned and already paid taxes on. By throwing it in, they get those taxes back. Cool. But then they make their money taxable again. This is not tax avoidance, or even tax deferral. It is tax illusion. You’re merely gambling that some day, decades from now, you’ll be taxed at a lower rate. That’s when we all get ponies.
Second, when you do collapse your RRSPs and suck out the money, it’ll be taxed as income. As with interest and rent, income’s taxed at the highest rate. Do you really understand this? If so, why would you put stocks, preferred shares, equity mutual funds or ETFs inside a registered retirement plan? Sure the growth is tax free, but just think of the tax advantage you are squandering. Capital gains and dividend income are taxed at the lowest possible rate (about 15% on average), but coming out of an RRSP all growth and distributions are dinged for (on average) twice that amount. Duh.
Third, you can’t borrow money to invest inside an RRSP and deduct the interest. Fees you pay to have one managed are not tax-deductible. Nor are trading costs or commissions. But if you contribute to a non-registered plan, then everything can be written off your taxable income – and the money you take out later to live on is tax-free.
Fourth, what happens if personal tax rates increase? Exactly. You are a screwee. After all, does anyone on this diseased blog really believe that economic growth will allow the federal or provincial governments to balance their budgets, banish deficits and rescue health care, what with corporate taxes going down and wrinkly Boomers set to suck the system? An increase over the next ten or 20 years might mean you get a tax break now only to cash in RRSPs later at far higher rates. Bummer.
Fifth, the first ‘R’ means ‘registered.’ These are funds the government tracks, monitors and controls. Years ago some politicians in Ottawa proposed a ‘small’ tax on the RRSPs of wealthy people (those with a few hundred grand in there). Smart idea. After all, investors are sitting ducks, able to avoid such a tax only by withdrawing funds – and being taxed. Now imagine an NDP government…
Sixth is the myth most of us subscribe to, that our tax bracket is always higher when we work than when we retire. Hence, smart to RRSP. But for many people it doesn’t work that way. If they have any kind of a pension, or start adding in the CPP and OAS, or are smart with their non-registered investments, they can soon find themselves in the same bracket as when they were workies (or higher). This is not pleasant but better than poverty (which is why RRSPs are best suited to lower income earners).
Seventh, all RRSPs eventually turn into cashable income. You can only hold out until age 71, then these things rupture into an income stream you must take, and declare. If your RRSP is fat this can push you into a higher bracket. This, plus most of the points above, is why RRSPs can become tax bombs.
Finally, this additional income and the tax consequences can result in having your government benefits, like OAS, clawed back. And while I know most struggling families have zero sympathy for old farts being raped by the CRA, tough. Why should retired people be financing F-35 Lightning II Joint Strike Fighters?
So, are RRSP useless? Of course not. Somebody has to support starving Investor’s Group reps.
Actually there are four excellent reasons to consider making a contribution – yet only in certain circumstances. But I’m tired of typing. Tomorrow. Then we rock.